1. Field of the Invention
The present invention relates to a financial data processing system and method for selecting an investment portfolio of companies with substantial price appreciation potential, based on a newly discovered association between stock price appreciation and the technological strengths of the companies, where technological strength is measured through indicators derived from the companies' patent portfolios. More particularly, the systems and methods of the present invention rank companies by a technology score derived from an analysis of at least the number and growth rates of company patents, citations to company patents from later patents, the references from company patents to earlier patents and research papers, and historical stock price appreciation. Because these technology strength indicators have not heretofore been available to investors, they allow technologically undervalued and technologically overvalued companies to be identified, and allow investors to assemble a portfolio of technologically undervalued stocks which should substantially "beat the market", and to avoid investing in companies which are technologically overvalued in the market.
2. Prior Art
In the last decade of the 20.sup.th Century it has become widely accepted that invention and innovation are fundamental forces driving the U.S. high-technology economy, and that much of the growth in the Western Economies can be traced to the close links between the growth of scientific knowledge and the use of technology. (See N. Rosenberg, and L. E., Birdzell, Jr. "Science, Technology and the Western Miracle." Scientific American 263 (5) [1990] 42-54.) While this has been clearly perceived at the national policy level and in the aggregate by the general rise of technology stocks, direct linkage of company technology and stock price has remained elusive. In particular, although empirical research has established that corporate patenting is associated with subsequent gains in firms' productivity (see Zvi Griliches, "Patent Statistics as Economic Indicators: A Survey." Journal of Economic Literature 28 [1990] 1661-1707), this general relationship has not yet been applied to stock portfolio selection, although contemporary research indicates that this is likely to be successful. (See Zhen Deng, Baruch Lev and Francis Narin. "Science & Technology as Predictors of Stock Performance." Financial Analysts Journal, 55 [May/June 1999] 20-33), and Francis Narin, Elliot Noma, and Ross Perry, "Patents as Indicators of Corporate Technological Strength." Research Policy, 16, [1987] 143-155).
Part of the reason that stock pricing models have not focused on technology is that public information about firms' R&D activities is inadequate for the purpose of investment analysis. The firm's periodic R&D expenditures, the sole innovation-related item required to be disclosed in financial statements, is too coarse an indicator of the nature, quality and expected benefits of its science and technology. Firms generally do not disclose information about the nature of their science and technology, nor can investors glean from R&D cost data the substantial differences that exist across firms in innovative capabilities. Furthermore, various innnovative activities, particularly in small companies, are not formally classified as R&D, and hence are not reported separately to investors. Consequently, publicly available information on firms' science and technology is inadequate for assessing the capabilities of firms to innovate and the impact of such innovations on future corporate performance. Patent citation analysis provides a potentially important tool for overcoming many of these data inadequacy problems.
The extensive documentation accompanying patent applications includes a wealth of information from which various aspects of the quality of firms' science and technology can be learned. Of particular relevance are the references cited in the patent documents which identify earlier inventions ("prior art"), in the form of previous patents or scientific papers and articles relevant to the extant patent application.
Economists have in recent years examined the usefulness of patent citations as output measures of firms' innovative activities, supplementing R&D expenditures, which are an input measure. For example, it has been shown that the intensity of citations to a set of patents in subsequent patents was related to the social gains from the examined patents. (See Manual Trajtenberg. "A Penny for your Quotes: Patent Citations and the Value of Innovations," Rand Journal of Economics 21, [1990] 172-187). Other research has shown that patents highly ranked by industry staff were more frequently cited than patents of lower rank, (see Michael B. Albert, Daniel Avery, Paul McAllister, and Francis Narin. "Direct Validation of Citation Counts as Indicators of Industrially Important Patents," Research Policy, 20 [1991] 251-259) and that the intensity of citations to firms' patents is associated with their market values. (See Bronwyn H. Hall, Adam Jaffe, and Manuel Trajtenberg. "Market Value and Patent Citations: A First Look." Paper prepared for the Conference on Intangibles and Capital Markets, New York University, [1998]). Recent work also shows that patent renewal and citation frequency are correlated (see Patrick Thomas. "The Effect of Technological Impact Upon Patent Renewal Decisions," Technology Analysis & Strategic Management, II, 2, [1999] 181-197) while an early paper showed that patents associated with important inventions were twice as highly cited as control patents. (See Mark P. Carpenter, Francis Narin and Patricia Woolf. "Citation Rates to Technologically Important Patents," World Patent Information 4, [1981], 160-163). Finally, pioneering patents were found to be cited 5 times as frequently as ordinary patents. (See Anthony Breitzman and Francis Narin. "A Case for Patent Citation Analysis in Litigation," Law Works, 3, 3, [March 1996] 10-11, 25-26). Prior evidence thus substantiates patent citations as valid indicators of firms' science and technology.
The fundamental idea underlying the economic analysis of patent citations is that a large number of citations to an earlier patent from later patents indicates that the earlier patent is an important invention, one that has led to numerous subsequent technological improvements. It follows, that a company whose patent portfolio contains a large number of highly cited patents is one that is generating innovative technology, likely to yield important inventions and successful products. Thus, one would expect that companies whose patents are highly cited would tend to be more successful innovators and perform better in both the real and capital markets than companies whose patents are less frequently cited.
Other attributes of patent citations may indicate additional aspects of the quality of firms' science and technology. One such attribute is the "Science Linkage" of a company's patents, which indicates the number of references in the firm's own patent applications to scientific papers, as distinct from references to previous patents. (See Francis Narin, Kimberly S. Hamilton and Dominic Olivastro. "The Increasing Linkage between U.S. Technology and Public Science," Research Policy, 26.3, [1997] 317-330). Science Linkage thus indicates how close to science, or to basic research the fins R&D activities are. Science Linkage is very industry dependent: close to zero in mechanical technologies and up to 15 or more in advanced biotechnologies.
In general, companies that are innovating rapidly should be more successful in product development and marketing than firms relying on old technologies. This leads to another citation indicator, "Technology Cycle Time," which measures the median age of the U.S. patents cited in the firm's patents. A tendency to cite mature patents indicates that the firm engages in old technology. Note that this measure too is industry dependent. Technology Cycle Time is as short as three to four years in rapidly changing industries, such as electronics, and as long as 15 years in slow moving technologies, such as ship building. In drugs and medicine, the Technology Cycle Time tends to be eight to nine years, which is in the middle range of the overall Technology Cycle Time distribution, implying that important advances in drugs and medicine are not coming from rapid increments in technology, but rather from basic scientific research. A comprehensive discussion of these indicators are contained in the background material to the Tech-Line.RTM. database (see Francis Narin. "Tech-Line.RTM. Background Paper, In: Measuring Strategic Competence," Imperial College Press, Technology Management Series, Professor Joe Tidd, Editor [1999]).
The need for adequate consideration of technology in stock selection is growing. Professor Baruch Lev asserts that it is becoming more apparent that purely financial indicators are of less and less precision in estimating the future performance and the stock value of a company, presumably because the quality of company's technological accomplishments, and the inventive capital it is building up through its patent portfolio, trademarks, trade secrets, and other non-financial capital, are becoming more and more significant components of company performance. (see Baruch Lev and Paul Zarowin, "The Boundaries of Financial Reporting and How to Extend Them" Presented at The Conference on Intangibles and Capital Markets, NYU May 13, 1998)
Despite the obvious attractiveness of using technology indicators in stock market analysis, there are some formidable barriers to using these techniques in stock selection which are just now being overcome.
Not the least of these barriers is the problem of matching patent assignee names to individual companies. Companies patent under many different names such as divisional names, and joint ventures, even when those patents are ultimately owned by a single company. In addition, accounting for mergers, acquisitions, and divestitures is a major challenge. For example, the 1,100 heavily patenting institutions covered in CHI Research's Tech-Line.RTM. database, including approximately 500 U.S. and 500 foreign companies, patent under more than 20,000 different assignee names, so that assignee unification is an important first step in the application of patent analysis to stock selection.
In addition, large numbers of patents are reassigned from one company to another, because of mergers and acquisitions and for other reasons, and the hundreds of thousands of reassigned patents should also be assigned as accurately as possible to the company that actually currently owns them.
In summary, background research provides a strong rationale for the expectation that companies with strong patent portfolios would perform better in the market, and that if a method could be devised to accurately measure the quality of company technology, then one would expect that this have a significant predictive effect on company stock performance. Furthermore, information of this type should be particularly valuable because it is not currently available to market analysts, leading to a strong likelihood that the quality of company technology might not be properly valued in the market.
The data processing system and methodology revealed in this patent solves this problem.